Paper Outline
The objective with this paper is being written is to provide a comprehensive discussion for IAS 16-Plant, Property and Equipment and IAS 40-Investment Property. It is considerable that many a times, be it academicians or nascent professionals, appropriate accounting for property under the provision of IAS has always been the source of confusion. Therefore, this project will detail all the major provisions under IAS 16 and IAS 40 and how each of them differs from each other.
As part of this paper, we will first individually detail both the accounting standards and will then illustrate the differences using appropriate examples. Important to note, in order to provide high credibility to my work and to provide the readers with authentic accounting provision for these two standards,we will solely rely on academic journals and official website of IAS.
IAS 16- Property, Plant and Equipment
-Overview
Issued in the year 1993, IAS 16 is the financial accounting standard adopted by International Accounting Standard Board(IASB) and is objectified with the appropriate accounting treatment and disclosure of property, plant and equipment so that the end users of the financial statements are able to collect information about an entity’s investment and holding of property, plant and equipment, and also any changes in such holdings. (IFRS, 2012)
The standard exclusively states that since land and buildings are separable assets, they should also be treated separately for accounting purpose, even if they are acquired together in one transaction. For instance, while Land has an unlimited useful life and cannot be depreciated, Buildings, on the other hand, have limited life and are thus exposed to depreciation. Similarly, equipments, which are put into use during the normal course of production, are also depreciated owing to normal wear and tear during the production process. (IFRS, 2012)
Therefore, the principal issues dealt in the IAS 16 for accounting of property, plant and equipment are recognition of assets, determination of carrying amount and the depreciation as well as impairment losses associated with these assets
-Definition
The standard defines property, plant and equipment(PPE) as the tangible assets, that are:
a) Held for use in the production activity of the entity, for supply of goods and/or services, for rental to others or is put to use for administrative purpose
and
b) Expected to be used for more than one accounting period
(Deloitte, 2016)
-Scope
IAS 16 applies to all the property, plant and equipment except for the situation when another standard requires or permits the different accounting treatment. Accordingly, some of the assets that are not covered under IAS 16 are:
Assets held for sale
Biological Assets
Assets related to mineral rights and exploration
Assets held under the discontinued operations provision
(Deloitte, 2016)
-Recognition and initial measurement
According to IAS 16, the cost of an item, defined as property, plant and equipment under the standard, shall be recognized as an asset, provided:
It is probable that the entity will reap economic benefits associated with these assets, and such benefits will eventually flow to the entity
Cost of such asset can be measured reliably
(European Union-IAS, 2009)
Here, the term cost refers to:
a)Purchase price of the asset, including any import duty, purchase taxes(non-refundable), net of any discount or rebate offered on the purchase
and
b) Cost related to transportation of the asset from the point of purchase to the point of operations, and any other cost spent to turn the asset capable of operating in the manner deemed fited and desired by the management of the entity
c)Initial estimate for dismantling and restoring the site
(European Union-IAS, 2009)
d) Related professional fee for architects and other engineer s, who may be consulted for the asset relate purchases
Important to note, the cost of the item classified as property, plant and equipment is cash price equivalent at the recognition date. However, if the entity has not paid the entire amount in cash and if the payment is deferred, the difference between cash price and the total payment is recognized as interest over the period of credit, with a condition that the firm does not capitalize such interest in accordance with IAS 23. (IFRS, 2012)
On the other hand, if the asset has been acquired in exchange of another asset, the entity is required to measure the cost on the fair value basis, provided there is commercial substance to validate the exchange transaction and the fair value of the asset acquired and the asset given up is measurable. If these two conditions are violated, the asset will be recognized on the carrying amount of the asset given up.(IFRS, 2012)
-Measurement after the initial recognition
While IAS 16 mandates the initial measurement of property, plant and equipment on cost basis only, it does permit the entity to use either the cost model or the revaluation model for recognition post the initial recognition. Important to note, once the entity decides to use either the cost or revaluation model for the recognition purpose, it may apply that policy to the entire class of property, plant and equipment. Below we have detailed the cost model and revaluation model:
a)Cost Model:
As per this model, post the initial measurement of the asset on cost basis, the entity may continue to recognize an item of property, plant and equipment on cost less accumulated depreciation any accumulated impairment losses.(IAS, 2016)
b) Revaluation Model:
As part of this alternative model, an entity is permitted to perform subsequent recognition of the asset on the fair value basis, provided the fair value of the asset can be measured reliably. Once the fair value of the asset is recognized on the date of recognition, the asset shall be recorded at fair value less less any subsequent accumulated depreciation and subsequent accumulated impairment losses.
i) Recognition of gain and loss on revaluation:
If the carrying amount of the asset is increased because of the revaluation, the gain is recognized in the other comprehensive income and is accumulated under the revaluation surplus. Here, the increase is allowed to be recognized in the profit or loss statement to the extent that it reverses a revaluation decrease of the same asset previously recognized in profit or loss statement. Similarly, if the carrying amount of the asset is decreased because of the revaluation, the decrease should be recognized in the profit or loss statement, and the decrease can be recognized in the other comprehensive income section only to the extent of any credit balance existing in the revaluation surplus in respect of that asset. (IAS, 2016)
Important to note, IAS 16 standard requires that the entity adopting the revaluation model is required to perform the revaluation of the asset involved on a regular basis in order to avoid material differences between the carrying amount of the asset and fair value on the balance sheet.
ii) Recoverability of the carrying amount
IAS 16 requires that if an asset can no longer be used and the entity does not expect any material use from it, the entity is required to perform impairment testing and under no condition, such asset will be carried at amount more than its recoverable amount, so determined through impairment testing. Here, the recoverable amount is greater of the asset’s fair value less cost and its value in use. (IAS, 2016)
-Asset Depreciation under IAS 16
IAS 16 requires that whether the entity opts for cost model or revaluation model post the initial recognition, each asset should be depreciated on a systematic basis over the asset’s useful life. In addition, the entity is required to review the residual life and the useful life of the asset atleast at the time of year-end, and if there is any change, the same must be applied prospectively. Similalry, if the entity wishes to change the depreciation method because of change in the pattern of consumption, the change should be applied prospectively again. However, the entity should only choose that depreciation method that reflects the pattern in which the asset’s economic benefits are consumed by the entity.(IFRS, 2012)
-Asset treatment on disposal or derecognition
IAS 16 requires that if the entity dispose any asset or withdraw the same from any future use and expects no subsequent benefits from such asset, in that case, the asset should be removed from the balance sheet of the company. Important to note, any gain or loss on disposal of the asset should be recognized in the profit and loss statement. However, in case the entity decide to put the asset on rental basis, the asset should then be transferred to inventories and be recorded at its carrying amount with the classification of ‘held for sale asset’. (IFRS, 2012)
IAS 40-Investment Property
-Overview
Issued in the year 2000, IAS 40 is the financial accounting standard adopted by International Accounting Standard Board(IASB) that discusses the accounting provisions related to property, both land and building,held by an entity with the intent to earn rental income or capital appreciation or both. The standard is an exclusive access for the users of the financial statements to understand that the accounting provision for land and building held for the investment purpose, is completely different from the provisions when the land and buildings are used in the production activity.
In short, the objective of this standard is to prescribe prudent accounting treatment for property held for investment purpose and other related disclosures.
-Definition
The standard defines investment property as a property, both land or building, held either by the owner or the lessee under the finance lease, with the objective to earn rental income or to earn capital appreciation from the same. Therefore, any property, that is used in the production or supply of goods or services, or for administrative purpose or for sale in the ordinary course of business, cannot be classified as an investment property. In addition, the standard has also been flexible with the property that is held by the lessee under the operating lease, and allows for its classification as an investment property, provided the lessee meets the definition of investment property, treat the operating lease as finance lease and last, use the fair value model for the asset recognized. (IAS, 2016)
-Scope
IAS 40 includes the property held for investment, i.e. to earn rental income or to earn capital appreciation from the same. Accordingly, following assets are classified as invent property:
Land/Building held to gain capital appreciation
Land/Building held for an undetermined use
Building leased out under the operating lease
Vacant Building available on lease contract
Property under construction or development, with the intent to be used as investment property in the future
However, IAS 40 does not categorize the following properties investment properties:
Land or building use for production of goods or services
Land or building use for the administrative purposes
Building being constructed on behalf of a third party
Property occupied by the owner
Property leased to another party under the operating lease
(Ellis, 2012)
-Recognition and initial measurement
According to IAS 40, the investment property shall be recognized as an asset, provided:
It is probable that the entity will reap economic benefits associated with these assets, and such benefits will eventually flow to the entity
Cost of such asset can be measured reliably
IAS 40 mandates that any investment property held by an entity should be recognized at cost initially.
Here, the term cost refers to the purchase cost of the property plus any additional transaction cost, startup cost, abnormal cost or any initial operating losses incurred before the investment property achieves the planned level of occupancy.
On the other hand, the initial cost of property held under lease shall be recognized at the lower of the fair value of the property and the present value of the minimum lease payments.
(IFRS, 2014)
-Subsequent measurement
While IAS 40 requires initial recognition of the investment property on cost basis, any subsequent recognition is permitted to be done either on the cost basis of fair value basis. Important to note, the standard requires that only one valuation model should be used for all the investment property’s held by the entity. Below we have discussed the two valuation models:
a)Cost Model:
As per this model, post the initial measurement of the asset on cost basis, the entity may continue to recognize an item of property, plant and equipment on cost less accumulated depreciation any accumulated impairment losses.(IAS, 2016)
b) Fair Value Model:
As per this model, the entity is required to perform fair value measurement for the investment property, and any changes in carrying value are recorded in the profit and loss statement.
The standard defines fair value as the price that would be received by the entity, if it wish to sell the asset or use the same to transfer a liability in an orderly transaction between market participants at the measurement date.(IAS, 2016)
-Disposal
IAS 40 requires that if the entity decides to withdraw the investment property permanently and seek no future economic benefits from it, in such case, the investment property should be de-recognized and be removed from the balance sheet. Any gain or loss on disposal of the investment property should be disclosed on the income statement.(IFRS, 2014)
Difference between IAS 16 and IAS 40
On the basis of the above discussion of the provisions relating to IAS 16 and IAS 40, it is clearly evident that while both the models deal with land, building and property, however, the core essence of both the standards is widely different. As for IAS 16, this standard discusses the accounting provisions for land and building that used for the production of goods and services or the one that are involved in the normal course of business. On the other hand, IAS 40 relates to the land and building that are held exclusively for investment purpose, i.e. either to earn rental income or to gain capital appreciation from the same.
Another prima-facie difference between both the standards is related to fair value measurement. Important to note, under the provisions of IAS 16, at the time of revaluation of the asset, any gain or loss is reported in the other comprehensive income and is then accumulated in revaluation reserve. On the other hand, as per the provision of IAS 40, any revaluation gain or loss of the investment property, is reported in the income statement. (Fee, 2010)
Conclusion
At the end of this paper, we can surely commend the transparency and simplicity, which Internation Accounting Standard Board(IASB) has put into the discussion of the accounting provisions related to IAS 16 and IAS 40. As we had discussed in the preceding section, while both the standards relate to property, land and building, however, without the proper classification, users of the financial statements may not as which asset belongs to what category and thus may fail to understand the financial position of the subject entity. Therefore, both IAS 16 and IAS40, helps us in understanding the difference between the land and building used in the ordinary course of business and the land and buildings that are held solely for the investment purpose.
References
IFRS, (2014). IAS 40 Investment Property. [online] pp.1-2. Available at: http://www.ifrs.org/IFRSs/Documents/Technical-summaries-2014/IAS%2040.pdf [Accessed 16 Jul. 2016].
Ellis, M. (2016). IAS 40 Investment Property : Accountancy Students. [online] Accountancystudents.co.uk. Available at: http://accountancystudents.co.uk/ias-40-investment-property/ [Accessed 16 Jul. 2016].
Fee, H. (2016). Accounting for Property – Classification is Key!. [online] Ireland: CPA Association, Ireland, pp.2-5. Available at: http://www.cpaireland.ie/docs/default-source/Students/Study-Support/P2-Advanced-Corporate-Reporting/accounting-for-property---classification-is-key.pdf?sfvrsn=2 [Accessed 16 Jul. 2016].
IAS 16 Property, Plant and Equipment. (2012). [online] IFRS, pp.1-2. Available at: http://www.ifrs.org/Documents/IAS16.pdf [Accessed 16 Jul. 2016].
Iasplus.com. (2016). IAS 16 — Property, Plant and Equipment. [online] Available at: http://www.iasplus.com/en/standards/ias/ias16 [Accessed 16 Jul. 2016].
Iasplus.com. (2016). IAS 16 — Property, Plant and Equipment. [online] Available at: http://www.iasplus.com/en/standards/ias/ias16 [Accessed 16 Jul. 2016].
Iasplus.com. (2016). IAS 40 — Investment Property. [online] Available at: http://www.iasplus.com/en/standards/ias/ias40 [Accessed 16 Jul. 2016].
International Accounting Standard 16 Property, Plant and Equipment. (2009). [online] IAS, pp.1-13. Available at: http://ec.europa.eu/internal_market/accounting/docs/consolidated/ias16_en.pdf [Accessed 16 Jul. 2016].
